mhy729 (30.53)

question on "valuation allowance"

2

Hi, I am hoping someone can help me with the term "valuation allowance", and any related information that would be helpful in understanding what it is about. My original observation/question comes from the recent financial statements by XIDE, which I took a look at after reading the TMF article "Exide Technologies Misses on Revenues but Beats on EPS", at the following link:

The one really important thing about the financial report (and seemingly indicated by the "unusual" event of having a revenue miss but earnings beat--and a big beat at that) is found in one line in the income statement reading:

Income tax (benefit) provision [of] (60,313)

The "Notes to Financial Statements" item "(12) INCOME TAXES" states the following:

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The effective tax rate for the first nine months of fiscal year 2012 and fiscal year 2011 is (7,283.5%) and 6.5% respectively. The effective tax rate for the first nine months of fiscal 2012 included the recognition of taxes on income and losses in almost all of the Company’s jurisdictions with the primary exception of the United Kingdom and Spain, on which full valuation allowances are recorded. The Company released the valuation allowance for France in the third quarter of fiscal 2012 after determining that it was more likely than not that the Company would realize all deductible temporary differences and carryforwards in the foreseeable future. In fiscal 2011, the Company released full valuation allowances for Australia and Italy based on this same more-likely-than-not criteria.

The effective tax rate for the first nine months of fiscal 2012 was impacted by the following discrete items: release of a valuation allowance in France of ($76.7) million; the settlement of the 2003-2010 Spanish audit for $13.4 million; and recording of a valuation allowance on a Portugal deferred tax asset of $1.6 million.

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It would appear that this "valuation allowance in France of ($76.7) million" is what accounts for that rather large income tax benefit which boosted earnings for the qtr, despite the poor revenue performance. Can anyone please explain what all of this means? This certainly looks like a one-time thing, and doesn't seem to me to indicate that anything really positive has happened with the company.

I accessed the 10q through the SEC website, and here's a link to an "interactive" version:

It looks as though they had deferred tax assets but at one point management decided that future earnings would not be sufficient realize a portion of these tax assets. So they established a valuation allowance. Now they believe they will realize the tax benefits and so they released a portion of this allowance.

It looks like this may have started in 2009. Pre-Tax income was ($36.3M) yet they recorded $32.2M in income tax expense. But some of that is due to the fact that they have different operations in different tax jurisdictions so they may have had to pay taxes in some areas and not others depending on that. But part of it is due to creating valuation allowance here. It wouldn't surprise me if more of these have been created over the years.

The whole thing looks difficult to unravel without going through several annual statements (as far as I can tell at least) which would also make it possible for earnings manipulation to be going on. I wonder if management bonus is tied to EPS. Without that tax benefit, trailing earnings would be negative.

Thanks somrh! That was very helpful for me, simply explained and easy to follow. I was also wondering about earnings manipulation, but refrained from mentioning that to not appear as if I were "getting ahead of myself".